MorningWord 06/12/14: LULU’s Lemon

by Dan June 12, 2014 9:34 am • Commentary

Last week on CNBC’s Fast Money, I debated a very formidable opponent in Brian Kelly on the set up for LULU into this morning’s Q1 report. Without having any real insight as to the current fundamentals, my thesis was simple. With sentiment as bad as it is, short interest as high as it is, new management’s possible reluctance to lower guidance and the stock down 50% from all time highs, the stock would rally on the slightest bit of good news.  As you can see from watching the video below, BK summed up my “bull” case fairly succinctly, “that wasn’t exactly a ringing endorsement.”

Well, there was little to no good news in this morning’s report and the company lowered full year guidance in addition to the announcement of the departure of their CFO.  My inclination to play for a bounce was obviously not correct with the stock down 16% in the pre-market. The most important takeaway is that broken stories don’t just fix themselves overnight.  The company has faced a perfect storm over the last 9 months with increasing competition, over-exposure to high-end consumers in a tough retail environment, high valuation, decelerating growth, management shake-up and… where do I stop?

Last week we debated playing for a bounce primarily because we thought the set up was SO BAD that maybe it could be GOOD for a defined risk sentiment trade (here.) We concluded:

While the stock looks like a hard press on the short side, the likelihood that the new CEO would have lower guidance in his second quarter with the company is also pretty low, but it’s hard to ignore the poor price action since the last print, poor relative strength to peers and the broad market and nasty technical set up.  If I were inclined to make a contrarian play I would look to define my risk. 

We decided to wait to take a closer look just prior to earnings and there was a piece of news yesterday that convinced us to stay away all together. The founder of the company Chip Wilson voted against re-election of the company’s current chairman (his replacement) and stated the current board is “heavily weighted to short term results”.  So the question we asked ourselves was what did the founder and ex-manager of the company know about the current situation to make such a public statement the day before a massive guide down??

When insiders are fighting it’s not because everything at the company is hunky dory.  Rather, they are fighting because the situation is bad.  There would be no power struggle at the top if Lululemon’s turnaround was showing improved results, and the board was commending the founder of the company on the renewed strength of the stock price.

In short, we pay attention when there is turmoil at the top.  In that vein, the departure of the CFO at LULU today is likely a sign of more trouble to come, and we don’t have an interest to try to catch this falling knife.